Why Marathon Petroleum Earnings Are At Risk

Marathon Petroleum (NYSE: MPC  ) will release its quarterly report tomorrow, and investors have gotten a lot more anxious about the prospects for the refining company's future. With one important advantage that the company benefited from having all but disappeared, Marathon Petroleum earnings will be under pressure and could remain so for some time.

The good times for refining stocks came from the fact that they were able to buy cheap crude from domestic producers at much cheaper prices than what prevailed on world markets. They then took advantage of high prices for refined products to sell into the world market at an immense profit. But as those tailwinds dissipate, Marathon and its peers now face higher input costs and potentially burdensome new regulation that could require massive capital expenditures. Let's take an early look at what's been happening with Marathon Petroleum over the past quarter and what we're likely to see in its quarterly report.

Stats on Marathon Petroleum

Analyst EPS Estimate

$1.90

Change From Year-Ago EPS

(25%)

Revenue Estimate

$23.57 billion

Change From Year-Ago Revenue

16.4%

Earnings Beats in Past 4 Quarters

3

Source: Yahoo! Finance.

Are Marathon Petroleum earnings doomed to fall?
Analysts have slashed their views in recent months on Marathon Petroleum earnings, cutting more than $1 per share from their June-quarter estimates and more than $2.50 per share from full-year 2013 expectations. The stock has followed suit, falling 10% since late April.

Marathon has already warned investors that its second quarter could look ugly. A couple weeks ago, the company said that it expected net income to come in between $570 million and $600 million, a far cry from the $814 million from the year-ago quarter. Narrowing margins were largely to blame for the drop in earnings.

The trend toward narrowing spreads between West Texas Intermediate and Brent crude prices has gone on for some time. The impact showed up in Marathon's results last quarter, although maintenance costs played an important role. Yet rival Valero (NYSE: VLO  ) managed to sustain and even grow its margins in the first quarter, although it recently saw those throughput margins fall fairly significantly in its second-quarter results last week.

Still, Marathon has taken steps to ensure it can still use unconventional sources of cheap oil. It upgraded its Detroit refinery to handle heavy crude from Canadian oil sands, thereby benefiting from still-substantial discounts in prices of Canadian oil compared to WTI.

The big question facing the industry is whether prices will continue to support export expansion. Phillips 66 (NYSE: PSX  ) is aiming to boost its export capacity by another 50% despite the fact that it's currently using only about half its existing capacity. Similarly, Tesoro (NYSE: TSO  ) recently noted that falling use of refined fuels in the U.S. is making refiners much more dependent on export markets for demand. In particular, with Mexican refineries not as able to deal with Mexican heavy crude as U.S. refiners, the circular trade whereby crude came in from Mexico to be refined and then shipped back in the form of gasoline and diesel looks likely to continue.

In the Marathon Petroleum earnings report, look closely at changes in margins to identify whether the company has still been able to access low-cost sources of crude oil inputs. Without those cost advantages, profits will inevitably suffer unless discounts for domestic crude return in the near future.

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